When people in defense talk about “buy-ins”, they are talking about a contractor who purposefully under-bids on a competitively awarded contract. Instead of expecting losses because of the underestimated costs, the contractor buys-in because its management thinks it can increase the contract cost later using:
(1) change orders (e.g., you Government have changed the scope of work which requires unanticipated costs and therefore the Government must pay), or
(2) follow-on work in production and sustainment, which are a far larger slice of the acquisition dollars.
Once a contractor is awarded a major development contract, so long as the program is not canceled due to 5x or 10x growth, the contractor is basically assured production and sustainment. They often own the intellectual property and are otherwise the only ones placed to do such work anyway.
This is why it is also often called “buying into production.” You may pay a price in development to earn the much bigger goodies on the back end, which are generally 90% of total program costs (and thus, total program profits).
Usually in the economic discipline of auction theory you have a “winner’s curse.” If every contractor’s bid is normally distributed around the actual production cost, then the winner with the lowest bid will always have underestimated the work and is expected to take a loss. In defense, you can call it the “winner’s blessing” because if you don’t win, you won’t earn the big profits on the back end and will likely be pushed out of the commodity market as the defense industry continues to consolidate around larger and larger programs.
Here is David Soergel testifying to Congress in 1975, “1975 Major Systems Acquisition (Part 2)”, pp. 336-37:
What causes buy-ins?
This is a particularly important one. The answer is, requiring contractors to propose very similar designs for an undeveloped system. Neither buyer or seller can precisely project a single undeveloped design’s eventual cost, particularly when new technology is involved. I would add that many current government efforts to refine cost estimates for new undeveloped systems are, in my opinion, useless when new technology is involved.
This is a critical point. The Government pre-contract process so narrowly defines requirements that often only a small range of solutions are viable, meaning that contractors compete mainly on price — if there is a competition at all.
Another point is that contractors usually underbid on R&D efforts to buy into production. So the buy-in problem occurs mainly on R&D contract awards. R&D goes after new technology, which by its very nature cannot be forecasted much less costed. Which means that contractors have an even greater ability to deny responsibility for overruns.
The pre-contract definition was addressed by Victor Deal in our podcast when he talked about Commercial Solutions Openings as a potential avenue for the Government to come in with a broader set of requirements. CSOs allow the contractors to propose sometimes “wild” solutions without fear of disqualification. Work is awarded based on merit, and not lowest price. Here is Victor again:
… when we think of competition, often times it’s look at as, this is the statement of work, this is the statement of objectives, and everyone who submits a proposal to that is trying to optimize against a single approach, rather than wild approaches that look at completely different ways to solve a problem.
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